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Can Online Travel Agents Survive This Turbulence?

Both sides in this escalating conflict are spending resources to fight a battle they don't want to fight.

Talk about biting the hand that feeds you. Online travel agent Orbitz Worldwide(NYSE: OWW), a creation of the airline industry, is now in a tussle with it over how travelers can book their flights.

So far, the biggest news has been about the conflict pitting American Airlines parent AMR(NYSE: AMR)against Orbitz and Expedia(Nasdaq: EXPE), but the situation is escalating and could quickly draw in all airlines and online travel agents (OTAs). The outcome is likely to change how travelers make their reservations and view the industry.

He who pays, gets to sayThe airlines have gotten addicted to lucrative nickel-and-dime fees for services. AMR posted its first profit in two years last quarter in large part because of fees for services it's imposed. So did Delta Air Lines(NYSE: DAL), which scored a profit for the first time in a decade, and US Airways, which recorded its third-largest profit ever.

And now American wants another piece of the pie for itself. It told Orbitz it wanted it to use the airline's in-house reservation system, Direct Connect, for booking flights with the airline instead of the global distribution systems run by Orbitz's parent, Travelport, or Sabre Holdings, which owns Travelocity. Those global distribution systems typically act as industry middlemen, facilitating the search for and booking of flights. In return, they charge the airlines fees for every flight booked.

When the airlines created Orbitz in 2001, the OTA received transaction payments, marketing support, and nondiscriminatory access to seat availability for published fares. In return, Orbitz paid American part of its GDS costs. In a separate supplier link agreement signed in 2004, Orbitz was required to book a specified number of seats using American's internal reservation system instead of through a GDS, for which the airline had to pay Orbitz a transaction fee for each ticket sold.

When the supplier link agreement was originally signed, it was estimated American would save up to 77% on every ticket booked through Orbitz, with industry savings exceeding $1 billion.

As American's business amounts to around 5% of Orbitz's revenues, along with Direct Connect's unproven track record of reliability and potential integration problems, Orbitz balked at making the move, which it says will limit customer choice.

American's golden parachuteOnce you've accepted that it's going to cost you more for a second checked bag, a pillow, and the myriad other fees airlines have imposed, American's argument begins to make more sense.

Aside from costing airlines more to use, the OTAs also prevent them from upselling travelers additional services.

Flight reservations are about more than just fares, though that's still the primary factor for many when choosing an airline. But many travelers also want options for checked luggage, priority boarding, or preferred seating, something they can't get when booking through Orbitz. With an OTA you're simply buying a fare.

Using American's Direct Connect system allows travelers to choose those options, which also gives the airline the opportunity to earn more revenues. The one-size-fits-all structure serves the OTAs well; the airlines, not so much.

Orbitz obtained a restraining order preventing American from pulling its fares from its system in November, but the courts refused to extend the deadline in December and American severed its ties to Orbitz.

Birds of a feather don't always flock togetherWith Delta dropping smaller OTAs and United Continental(NYSE: UAL) switching from Travelport to Hewlett-Packard's Shares reservation system, Expedia realized it was only a matter of time before they came knocking on its door. So it backed Orbitz and booted American's fares from its reservation system. The risk comes should the airlines decide to close ranks and back American's position, as an all-out war could fundamentally alter how travelers are able to book their flights.

Noticeably absent from the fray so far is priceline.com(Nasdaq: PCLN), which has eclipsed its rivals with stellar international growth. For good or ill, the leading OTA hasn't joined its industry in opposing the switch from the GDS system, and has avoided taking sides in other conflicts as well. When OTAs protested Google's (Nasdaq: GOOG) purchasing travel software giant ITA Software, Priceline refused to join the industry group FairSearch and, in fact, said Google's entry benefitted its business (Orbitz wasn't a member of the umbrella group either). Whether this is a smart tactical move by Priceline to undermine the competition and gain market share, or a philosophical difference in how the business operates, remains to be seen.

The blue and the grayAs a history buff, I'm fascinated how a minor skirmish in a sleepy town called Gettysburg ended up becoming the defining battle of the Civil War. What started with a desire to get boots for the soldiers culminated in one of the greatest, most poignant speeches a president ever delivered. In between, thousands of soldiers lost their lives and the course of U.S. history was changed.

You can't equate how someone books their next flight to a deadly armed conflict, but the process of a small skirmish blowing up into a much broader battle parallels how quickly this row over booking is becoming a much larger battle between two equally tenacious parties.

Off the radar screenAmerican Airlines really doesn't want to lose the online travel agents as a distribution source for its fares. Particularly during this past recession they were a useful means of filling up seats that otherwise would have gone unsold. Orbitz and the other OTAs, however, can't afford to have the airline industry united against it as selling seats on planes remains their lifeblood.

Last year industry researchers at PhoCusWright said the global distribution system used by Orbitz, Expedia, and Priceline accounted for two-thirds of all airline passenger revenue, or $81 billion, in 2008. Losing a good portion of that money to the airlines will crimp the OTAs business, which they see as a threat to their future, but in the escalating rhetoric and use of force by both sides, it may be that all parties end up pouring more resources into a conflict that neither one really wants to fight.

Author

Rich has been a Fool since 1998 and writing for the site since 2004. After 20 years of patrolling the mean streets of suburbia, he hung up his badge and gun to take up a pen full time.

Having made the streets safe for Truth, Justice and Krispy Kreme donuts, he now patrols the markets looking for companies he can lock up as long-term holdings in a portfolio. So follow me on Facebook and Twitter for the most important industry news in retail and consumer products and other great stories.